Deloitte’s Role as an Independent Auditor for CCME

February 7, 2011

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I understand that shorts have to exist in the market to balance the equation, and let me first say that after having read “The Art of Short Selling” thoroughly a couple of times, I have the utmost respect for fundamental short sellers such as Kathryn Staley, Jim Chanos and David Einhorn.

China MediaExpress (CCME) is a Chinese company that I currently hold and is currently under heavy scrutiny as a fraud. Reports by boutiques specializing on shorts have been released, and while I must give credit to Muddy Waters for the work they have put in to their report, the main argument of the shorter’s report is that the numbers are “too good to be true”.

But I’m going to present a case for at least why the SEC filings are accurate.

Independent Auditor Required

The role of an independent auditor is crucial in protecting investors from dishonest management and has to be indifferent to the board. The auditor should not be a friend of the company and should work completely independently.

With so much buzz about CCME, there have been comments made about how Arthur Andersen failed in their auditing duties of Enron, and this is true.

However, if you take the entire story of Enron in context, Arthur Andersen had been Enron’s sole auditor for 16 years. Arthur Andersen not only performed the audits but also providing consulting services to Enron earning $52m in 2000.

This is clearly not independent auditing. The relationship and the incentives were much too deep to be considered independent.

Which brings me to Deloitte.

Auditor for Bear Stearns

Deloitte was the auditor of Bear Stearns and it is true the auditor lacked judgement and overlooked red flags. But the red flags Deloitte overlooked when auditing Bear Stearns were not related to accounting gimmicks. All those red flags were related to risk and valuation for subprime. From an accounting standpoint and GAAP rules, Deloitte did nothing wrong.

But what about the point that the auditor of CCME is not Deloitte & Touche of the USA but in fact, Deloitte Touche Tohmatsu?

Deloitte Brought Down the “European Enron”

To to build on the case of Deloitte’s competence as an auditor, consider the case study of Parmalat.

Parmalat was once the largest Italian dairy company but is now classified as the “European Enron”. Parmalat is another case where the independent auditor missed the fraud in accounting.

Under Italian law, every company is required to switch auditors every 9 years. Parmalat changed their auditor from Grant Thornton to Deloitte & Touche and in the very first audit by Deloitte & Touche, offshore accounts were scrutinized and fraudulent offshore entities were exposed that were used to hide fake assets.

Deloitte Touche Tohmatsu Provided an Accurate Audit

What do these case studies have to do with CCME? The two main ideas are:

Deloitte was recently hired as the auditor.

Deloitte would have seen all documents and records from a fresh new perspective.

Deloitte Touche Tohmatsu, the auditor of CCME, is not 100% Deloitte & Touche, but Deloitte Touche Tohmatsu must operate under Deloitte & Touche rules and standards. To argue that just because Deloitte Touche Tohmatsu is auditing a Chinese company and thus open to manipulation and bribes is pure speculation and nothing but an opinion.

It would be equivalent to saying that Microsoft China is incompetent just because it operates in China and is subject to Chinese rule.

Conclusion: Accusations about the inability of Deloitte as an auditor debunked. SEC filings are correct.

Disclosure

Long CCME.

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